A violent movement in government bond markets sparked by the collapse of Silicon Valley Bank has upended one of the most popular hedge fund businesses of recent years.
The bank’s failure on Friday raised fears that the US Federal Reserve may have to steer away from aggressive interest rate hikes to avoid putting a strain on the country’s entire financial sector. It has also prompted some investors to seek secure retirements. Both of these factors pushed bond prices higher.
Analysts and investors say this was quickly met with a huge consensus in the markets that interest rates would continue to rise to fight inflation and bond prices would continue to fall – a bet that has generated outsized gains for many hedge funds last year. Now some of the same macro and computer hedge funds that celebrated a very successful year 2022 were caught off guard, sending some of them rushing out of positions and amplifying the bond market move.
“The major reversal in Treasuries has proven inflation trading – once against the tide – to be crowded,” said Andrew Beer, managing member of US investment firm Dynamic Beta, adding that the funds are on the rise. were rushed to change their positioning.
Market insiders say that is likely a factor behind the massive rise in bond prices on Monday, which sent the yield on the two-year US Treasury rating at the fastest pace since 1987. US government bond market volatility even surpassed the difficult conditions of the onset of the Covid-19 pandemic in March 2020 to reach its highest level since the 2009 financial crisis, according to the ICE BofA Move index, an indicator of the premiums investors are willing to pay to protect themselves against market fluctuations.
“It appears there has been some forced buying, due to the abrupt nature of the move,” said Gregory Whiteley, portfolio manager at DoubleLine Capital.
“It was a brutal day,” said a hedge fund executive whose fund lost money on Monday.
Market participants say many hedge funds were forced out of losing trades in the recent market turmoil. Among those to be affected is Rotterdam-based Transtrend, which manages $5.6 billion in assets and lost 9.6% on Monday. Man Group, one of the world’s largest hedge funds, lost 4.2% in its AHL Diversified fund and 2.2% in its AHL Alpha fund on Friday, as bonds also rebounded strongly.
Bets on rising yields brought big gains last year for managers such as billionaire trader Chris Rokos, whose Rokos Capital posted a 45.5% gain as the US two-year yield rose 0.73% to 4.4%, while Said Haidar’s Haidar Capital is up almost 200 percent, helped by bond bets.
In the first weeks of 2023, many speculators had argued that the price of the two-year U.S. Treasury note — which is sensitive to changes in interest rates — would continue to fall, according to data from the Commodity Futures Trading Commission. As of mid-February, the magnitude of these positions was at an all-time high, according to regulator figures. Funds were making more than twice as many bets on the US two-year note’s decline as on the rise, while on the 10-year it was more than three times as high. A cyberattack on data group Ion in January meant data was delayed, but violent movements in the rates market suggested the position had been held before SVB collapsed.
Many IT funds that try to catch on to financial market trends have long been betting against Treasuries and other government bonds as prices have fallen. According to Societe Generale’s trend indicator, which models the bets taken by these quantitative funds, they made negative bets on the two-year US Treasury for almost two years, and were also short on other large global government bonds.
While some managers were caught off guard by sharp falls in bank stocks, much of the pain for hedge funds has centered on bonds, whose prices are closely tied to changes in interest rates. Even though bond yields tumbled on Friday and Monday, equity indices remained relatively flat, which some investors said shows the move was not driven primarily by macroeconomic fundamentals.
“People don’t express a point of view,” said Christian Kopf, head of fixed income at Union Investment in Frankfurt. “It was a forced positional adjustment,” he said. When bond prices rose, it triggered bets on their decline, forcing hedge funds to close them, which drove prices higher and forced more negative positions to fall back – a classic feature of fast-moving markets. , albeit on a large scale.
Treasury yields rebounded on Tuesday, although they only erased a small part of the dramatic fall of the past few days. The magnitude of Tuesday’s move – a 0.3 percentage point move in the two-year yield – suggests the initial declines may have been exaggerated by speculative positioning in the markets.